Tax Freedom Day, which typically occurs in late April, according to the Tax Foundation, is the day when the nation as a whole has earned enough money to pay off its total tax bill for the year. So you may want to use this opportunity to determine if you can liberate yourself from some investment-related taxes in the future.
Actually, Tax Freedom Day is something of a fiction, in practical terms, because most people pay their taxes throughout the year via payroll deductions. Also, you may not mind paying your share of taxes, because your tax dollars are used in many ways – such as law enforcement, food safety, road maintenance, public education, and so on – that, taken together, have a big impact on the quality of life in this country. Still, you may want to look for ways to reduce those taxes associated with your investments, leaving you more money available to meet your important goals, such as a comfortable retirement.
So, what moves can you make to become more of a “tax-smart” investor? Consider the following:
Know when to hold ’em. If you sell an investment that you’ve held for less than one year, any profit you earn is considered a short-term capital gain, and it will be taxed at the same rate as your ordinary income. (For 2016, ordinary income tax rates range from 10% to 39.6%.) But if you hold the investment for longer than one year, your profit will be taxed at the long-term capital gains rate, which, for most taxpayers, will be just 15%. If at all possible, then, hold your investments at least long enough to qualify for the lower capital gains rate.
Look for the dividends. Similar to long-term capital gains, most stock dividends are taxed at 15% for most taxpayers. Thus, dividend-paying stocks can provide you with an additional source of income at a tax rate that’s likely going to be lower than the rate on your ordinary earned income. As an added benefit, many dividend-paying stocks also offer growth potential. With some research, you can find stocks that have paid, and even increased, their dividends over a period of many years. (Be aware, though, that companies are not obligated to pay dividends and can reduce or discontinue them at their discretion.)
Use those tax-advantaged accounts. Virtually all retirement accounts available to you, whether you’ve set them up yourself or they’re made available by your employer, offer some type of tax advantage. With a traditional IRA, or a 401(k) or similar employer-sponsored retirement plan, your contributions are typically tax-deductible and your earnings can grow tax deferred. Contributions to a Roth IRA, or a Roth 401(k), are never deductible, but earnings can grow tax free, provided you meet certain conditions. The bottom line? Contribute as much as you can afford to the tax-advantaged plans to which you have access.
Tax Freedom Day is here and then it’s gone. But by making some tax-smart investment decisions, you might reap some benefits for years to come.